Market could give economy a shot of adrenaline

VIEW FROM WALL STREET

April 21, 1991|By Thomas Easton | Thomas Easton,New York Bureau of The Sun

NEW YORK — New York--For fat cats who are scared -- or prudent -- enough to save, a 3,000 Dow presents a vexing problem: Where should they put their money?

For the rest of us, however, a rising market provides fewer clear reasons to cheer. Bull markets are always greeted by investors with qualified glee. Yesterday's roll of the dice has proved rewarding, but today's is already more expensive, and therefore just as, well, dicey.

For "advice," the current Fortune magazine reflects the norm. It contends easy money has already been made. Yet last fall, when the "easy money" rally was just beginning, Fortune also reflected the norm -- in its fall investment outlook, it warned readers about a "risky" market. Obviously, it's easier to reminisce than to forecast.

Given that market predictions, particularly in popular publications, are typically drivel, there may be more important aspects of the rally: What do high stock prices suggest about the broader economy, and equally important, what do they, by themselves, contribute to growth?

Stock prices traditionally rise prior to an economic recovery, with a gap of about four months, said Jeremy Siegel, a professor of finance at the Wharton School of Business at the University of Pennsylvania. That has prompted many economists to become optimistic about the near-term outlook.

But this market's usefulness as a barometer is already a bit suspect because stock prices bottomed in October.

"We are six months past the low, and I don't think we have hit the bottom of the recession yet. There are only fragmentary signs of a recovery," said Mr. Siegel. "What we have here is a very early stock market response, one can even say premature."

But even if the market's usefulness as a guide can be faulted, rich stock prices can still have a positive impact on the economy.

One way is through what economists label a "wealth effect." Rising stock prices enrich investors, and they, feeling better, spend. That channels money to others who will, in turn, respend, and so on, creating a chain reaction of economic adrenaline.

Wilshire Associates, a California investment firm, estimates the aggregate value of all stocks trades in the United States has risen $595 billion since the beginning of this year. Someone, somewhere, is richer.

Secondly, bull markets can provide cash for companies in need of money, whether it's to finance growth or retire overly onerous debt. During the 1984-to-1990 period, companies aggressively bought back stock -- in many cases, with borrowed money. Debt levels soared and, according to Steven Einhorn of Goldman Sachs, $600 billion in equity was bled out of the market.

So far this year, equity offerings are booming. According to IDD Information Services, $26.4 billion was raised in the first three months of the year, and Mr. Einhorn predicts that net of buybacks, up to $50 billion will be added to the equity base of U.S. companies this year.

"We haven't even scratched the surface in reversing the leverage added to balance sheets during the past decade," Mr. Einhorn said, "but I think it's an encouraging start."

One impetus for the trend to continue is the reaction of investors. During the 1980s, investors recoiled from new equity offerings by companies they already held shares in, fearing that the dilution of their position would outweigh any benefits that would come to the company because of more capital.

But shareholder reaction has been quite the opposite recently. The shares of many companies, including RJR Nabisco, Home Depot, Beneficial and Dillard Department Stores Inc., have risen after the announcement of secondary stock offerings.

"What I think the market is saying is that given the economic environment, a larger equity cushion is important," Mr. Einhorn said.

One beneficiary of the trend has, of course, been Wall Street itself. Profits announced last week by many of the major brokerage firms, including Merrill Lynch and Bear Stearns, were up substantially from last year's depressed level. Commissions from retail investors have come first; fees for underwriting of ferings are coming now. The combination has helped offset the dearth of money from the past decade's gusher: mergers and acquisitions.

But the benefits haven't just been limited to those who trade in money. Among the other beneficiaries have been the most troubled, and promising, areas of the domestic economy. Citicorp has raised capital and its share price has surged, making a subsequent round of capital-raising more feasible. Similarly, MNC Financial Corp. was able to spin off its credit card division for a higher price than expected and now, with its stock at $5 rather than under $2, as it was early this year, may be able to raise more money if it desires. Similar infusions may assist a string of companies -- manufacturers of everything from underwear to (literally) the kitchen sink -- that underwent leveraged buyouts during the past decade.